One Person Companies: Speed without effective brakes?

The introduction of One Person Companies in the 2013 Companies Act eyes fast economic gains; however, as
Shankar Jaganathan
points out, it also calls for a more considered approach and provision of safeguards to protect the smaller creditors and employees.

A new concept of 'One Person Company' has been introduced in India for the first time through the Companies Act 2013. Seen in historical perspective, it is a
radical change. Originally, a company as a distinct form of business organization emerged from the need to pool resources for undertaking large ventures that were
not feasible for one individual or a small group of individuals to finance. The word company is derived from the Latin word compagnia and is made up of the two
words cum meaning together and panis meaning bread; it represents a family sharing a common fortune. Seen in etymological context, therefore, the concept of a One
Person Company appears counterintuitive and an oxymoron.

Let us, however, look at the rationale behind this introduction. Since time immemorial borrowing has been considered a risky, dangerous job everywhere in the
world. If a loan was not repaid, the lenders had draconian rights. In Babylonia, the Hammurabi code gave the lender the right to take the borrower, his wife and
children as bonded labourers for a maximum of three years. In Rome, the Twelve Tables gave sanction for the borrower and his family to be taken lock, stock and
barrel and sold as slaves.

In India, Manusmriti authorized the lender to legitimately use any option.legal action, trick or force to recover their money. It is no surprise then that in this
environment, borrowers took more care than lenders when borrowing money. Given the potential high costs of borrowing, the wealth of the rich remained idle even as
the inventive and the adventurous ones with profitable ideas scrounged for money.

In the sixteenth century, starting with Europe, the global commercial landscape changed forever. The advent of the 'company' as a form of business organization
brought limited liability into play. With limited liability, an investor's resource committed to the company is limited to the originally committed investment and
with this in force, multiple investors came forward to fund promising ventures. These investors also borrowed money from others as loans to fund their projects.
However, when a venture failed, the investors could apologize and say sorry to their lenders who remained unpaid and get back to their earlier lives, with not
only their family secure but also their personal assets safe.

Empowered by the concept of limited liability, a new class of entrepreneurs characterised as risk seekers emerged, who were firm in their belief that success
would come to them tomorrow, if not today. Companies with their limited liability turned what was earlier a fatal pursuit of risk into a profitable one, thereby
fueling economic growth. Thus, promoting corporate activity in society no longer remained a commercial initiative for policy makers but soon became an economic
imperative.

Deriving the benefits of limited liability

Good entrepreneurs go beyond what is visible and look for the unseen. Over the years, as the value of limited liability became clear, entrepreneurs incorporated
companies in which they held all the shares leaving the bare minimum to other shareholders, holding one share each. In practice they had created what could be
called one person companies.

This was best illustrated in the case of Solomon, where the principle of limited liability was legally upheld by the House of Lords. Solomon, a 19th century
boot-maker, had a flourishing business. He decided to convert his sole proprietorship business into a company, Solomon & Company Limited. As seller, he received
£20,000 as shares and a balance £10,000 by way of debentures from the company. He distributed the shares received among his wife, daughter and four sons, who held
one share each to meet the legal requirement of seven members, while holding the debentures in his own name.

Over time, regulators in many countries recognized that companies could in reality be one-man shows and hence began to stipulate safety
mechanisms for these one person companies.

Sometime thereafter, a workmen's strike disrupted his business. This interruption led to the business failing commercially and having to be liquidated. The
company owed suppliers £7,000 but it had only £6,000 in assets. As the suppliers demanded payment from the company, Solomon as debenture holder also demanded
payment for his debentures of £10,000. Suppliers objected to his claim as they saw it as a repayment to 'self' before paying the third-party suppliers.

This dispute was resolved by the court which held that Solomon & Company Limited and Solomon were two distinct entities. The company's liability was limited to
the £6,000 it owned then and Solomon, the debenture holder, got this entire amount, with suppliers getting nothing. If the liability had not been limited,
creditors would have got the £6,000 from the company and their balance dues of £1,000 from Solomon's personal assets.

Protecting creditors

Over time, regulators in many countries recognized that companies could in reality be one-man shows and hence began to stipulate safety mechanisms for these one
person companies. The primary object was to protect small creditors and employees, who would be hurt if the venture failed. Liechtenstein, where the one person
company was first legally recognized in 1925, provided creditors the right to go beyond the limited liability company and access personal assets of the promoter
if there is gross negligence in management. In addition, where they suspect gross negligence, creditors can ask for dissolution of the company or inspect the
company accounts.

In the European Union, the ownership of any one person company is mandated to be made public by registration of these companies with regulators and providing
public the access to this information. In Germany, a minimum capital of .25,000 is prescribed as an additional condition.

India, in pursuit of strong economic growth, has introduced one person companies in the latest piece of legislation to tap the latent entrepreneurial talent by
providing them limited liability. To warn stakeholders of the nature of these companies, the new act requires them to suffix their names with OPC in brackets. In
addition, these companies need to file their accounts with the Registrar of Companies.

The only other mandate that the new act contains with a view to protecting
creditors is a record in writing of all contracts between the sole shareholder and the company. Given the precedents mentioned above and these minimal
requirements, one cannot help wonder if it would not be wiser to include additional stipulations that protect small creditors and employees of the one person
companies to be set up.

Rules proposed under the new act for one person companies limit their size to Rs 50 lakh in capital and a turnover of Rs 200 lakh. This is a measure in the right
direction to ensure that this concept is not misused by larger entities. Going further, a new condition could be imposed wherein third party liabilities -
consisting of creditors, loans and provisions - must be restricted to the capital. If this liability exceeds the capital infused, one person companies would stand
to automatically lose their limited liability. Such a provision would exclusively protect the small creditors and employees who have less bargaining power, in
contrast to lenders who can and do seek personal guarantee of shareholders to overcome limited liability.

The rationale for this suggestion is obvious as limited liability is a social construct and the benefit to one person cannot be at the cost of pain to a larger
number of employees and creditors. This provision could prevent the replay of the Solomon case and show that we have indeed learnt from history.

Shankar Jaganathan10 October 2013

Shankar Jaganathan is passionate about corporate governance, sustainability practices and economic history. His second book The Wisdom of Ants, A Short History of Economics was published in November 2012.

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National Physical

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